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The nearly perfect conviction record of Preet Bharara, the United States attorney in Manhattan, involving insider trading cases met its match in a federal appeals court.

The court’s decision overturning insider trading convictions of two hedge fund managers will make it more difficult for the Justice Department and the Securities and Exchange Commission to pursue cases against those who trade on confidential information that comes through a chain of sources.

The ruling represents the first significant appellate decision in a number of years that curtails the scope of insider trading laws. The decision, however, applies only to cases involving so-called tippees, so it should not pose a roadblock to all insider trading prosecutions.

On Wednesday, the United States Court of Appeals for the Second Circuit in Manhattan reversed the convictions of Anthony Chiasson and Todd Newman, whose case depended on confidential information received via analysts at their firms. The appeals court pointed out that the two were well removed from the insiders who furnished the information, and even from those who initially passed the confidential tips along.

Mr. Chiasson and Mr. Newman’s appeal hinged on how much knowledge the government must prove the defendants had about the source of the tip. Under the Supreme Court’s decision in Dirks v. S.E.C., the person who receives a stock tip from an insider — a tippee — is liable for insider trading only if the person knew or should have known the tipper breached a duty to keep the information confidential.

Under the Supreme Court ruling some 30 years ago, proving this involves two components. The first is whether the tipper owed a duty of trust and confidence not to reveal confidential information. The second is whether the tippee provided a benefit to the tipper (which the Supreme Court described as a quid pro quo). While money is an obvious reward, this can also include intangible benefits, like family ties or friendship, when money does not change hands.

The trial judge in Mr. Chiasson and Mr. Newman’s case told jury members that they only needed to find the defendants knew the tipper breached a duty; he left out any reference to whether the tippees knew there was a quid pro quo.

The appeals court found these instructions to be inadequate and stated that “without establishing that the tippee knows of the personal benefit received by the insider in exchange for the disclosure, the government cannot meet its burden of showing that the tippee knew of a breach.”

In a clear slap at Mr. Bharara’s campaign against insider trading, the appeals court criticized the “doctrinal novelty” of recent prosecutions aimed at tippees who receive information third- or even fourthhand.

“We note that the government has not cited, nor have we found a single case in which tippees as remote as Newman and Chiasson have been held criminally liable for insider trading,” the appeals court said. Thus, “the circumstantial evidence in this case was simply too thin to warrant the inference that the corporate insiders received any personal benefit in exchange for their tips.”

Rather than just reverse the conviction and send the case back for a retrial, the appeals court went a step further by finding that the government failed to introduce enough evidence to convict them. This is something it typically doesn’t do even when siding with a defendant. Thus, these two defendants cannot be retried for their trading in this case.

Under the double jeopardy protection of the Constitution, by not having enough evidence offered to convict them the first time, the effect is the same as if a jury had acquitted Mr. Chiasson and Mr. Newman at the end of their trial.

As DealBook reported, the decision also imperils the conviction of Michael Steinberg, a portfolio manager at the former SAC Capital Advisors, a target of the Justice Department’s crackdown on insider trading. He received some of the same information that Mr. Chiasson and Mr. Newman traded on and was similarly removed from the original tipper.

Mr. Steinberg’s appeal has been awaiting this decision, and the appeals court may return the case to the trial judge to apply its ruling to determine whether the charges should be dismissed for a lack of evidence of his knowledge of the tipper’s breach of fiduciary duty.

As with any judicial opinion, there are questions about how much it will affect future cases. The appeals court seemed intent on cutting back on how broadly the insider trading prohibition can be applied, but it did not preclude bringing a case against even a remote tippee under the right circumstances.

The latest decision does not give a free pass to hedge funds to trade on any confidential information they might gather as long as they can just deny knowing about the source. One way the government can prove a case is through a person’s “willful blindness,” which means ignoring red flags about the questionable nature of the information to avoid learning too much. Sometimes called the “ostrich instruction,” it allows a jury to find defendants can violate the law by putting their heads in the sand when it came to knowing whether how the information was obtained.

Furthermore, the appeals court rejected the government’s argument that friendship between the tipper and tippee is always sufficient. It is not enough to “prove the receipt of a personal benefit by the mere fact of a friendship, particularly of a casual or social nature,” the court wrote. Instead, a tipping case based on friendship will require “a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”

That standard will put pressure on the Justice Department and S.E.C. to show there was something more concrete passed to the tipper by the tippee than the warm feeling from helping a friend.

There have been cases based primarily on the friendship between the tipper and tippee, with little evidence of anything of value being given. Such cases may not be pursued in the future. A recent example involves a former officer of Eastern Bank who tipped off a golfing buddy about a planned acquisition of the bank. The officer recently pleaded guilty to insider trading, but may try to vacate the plea by relying on the appeals court’s decision.

Cases in which a tippee directly gave something to a tipper will be largely unaffected. The conviction of Raj Rajaratnam, the face of the government’s campaign against insider trading in hedge funds, would not be changed because he received tips personally from insiders and provided money and other benefits to them.

In contrast, the prosecution of Rengan Rajaratnam, Mr. Rajaratnam’s brother, resulted in an acquittal largely because the government could not show his knowledge of a breach of duty by the source of the information.

Moreover, trading on information about a future tender offer does not require showing a benefit was received because a violation of Rule 14e-3 involves only a defendant’s knowledge that it came from a party to the transaction.

It is still possible that the appellate decision itself will be overturned. The latest ruling involved just a three-judge panel of the United States Court of Appeals for the Second Circuit, so the Justice Department can ask all the active judges of the appellate court to review the decision. It can even pursue the appeal to the Supreme Court. Mr. Bharara issued a statement on Wednesday saying that his office was “considering our options for further appellate review.”

I suspect the government will not push the case further because the facts do not lend themselves to a very sympathetic hearing. There is a risk that the full panel of the Second Circuit or the Supreme Court could put even more restrictions on insider trading cases. Sometimes it is better to accept a defeat and move on to the next case than fight a battle unlikely to be won.